I am reading a paper that very briefly talks about some volatility arbitrage strategies. It's so brief that I do not exactly understand how it works. It says one of the strategy is based on "short spot index volatility, long on implied volatility" on the premise that IV > realized volatility. I know how one can trade implied volatility (using a delta-hedged option portfolio), but how can I trade spot volatility?

The other arbitrage strategy is supposedly based on volatility smile: "short stock smile, long stock volatility". So unless there is a way to trade spot volatility, this seems like a contradiction.

$\begingroup$perhaps you could provide a link to the paper mentioned in your question$\endgroup$
– ProbilitatorApr 7 '14 at 7:01

$\begingroup$Unfortunately that paper is confidential. It's primarily about correlation derivatives, and doesn't provide any additional information about the strategies than those I have mentioned.$\endgroup$
– PayaApr 7 '14 at 13:59

nicolas is quite right. For completeness, AccuShares has registered new products (the VIX Up and VIX Down shares, filing here) which are designed to track spot VIX. However, this approach has not worked out particularly well in the past (consider UCR and DCR).

I do not agree with nicolas. I think that spot volatility is represented by the front month expiry options while future volatility is represented by e.g. VIX and VSTOXX which are inherently based on a mix with options in further expiries.

The first thing you have to understand that volatility is an abstraction, and there are different possible implementations of this abstraction in terms of trading.

When someone writes "short spot index volatility, long on implied volatility" they mean something like take a position in options (implied vol) and delta hedge in the underlying instrument, which creates an offsetting P/L with "spot" (underlying) volatility.